"Using up" redraw?

Discussion in 'Accounting & Tax' started by qikiqtarjuaq, 31st Oct, 2017.

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  1. qikiqtarjuaq

    qikiqtarjuaq Member

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    Just wanted to a quick question re preserving deductibility (as opposed to increasing it). I've read through many threads and googled but can't seem to find anything on this specific question.

    Say I have an existing P&I loan that has built up redraw. I want to redraw excess funds into a clean (empty) offset account attached to that loan, and use it for the sole purpose of making P&I payments into that loan until "used up". Nothing else would go into or leave this offset account until this has been completed. This would not increase deductibility, however it would mean incoming cashflow could be directed elsewhere. I would not be claiming extra interest, just delaying paying off the loan. Are there any adverse tax implications? Any advice greatly appreciated.
     
  2. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Yes
    This is capitalising interest.
     
  3. qikiqtarjuaq

    qikiqtarjuaq Member

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    Thanks Terry, could you please explain how so? I understand capitalising interest = bad, not deductible, but I'm not understanding how it applies here.

    Say $300,000 loan, $20,000 redraw, interest currently paid on loan balance $300,000 ($320,000 limit loan balance).

    Redraw into offset, interest is still paid on loan balance of $300,000, so now $320,000 loan, $20,000 in offset, but payments now come from offset. Where is the capitalisation happening? I knew there would probably be issues, but just trying to wrap my head around it.
     
  4. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    capitalsing interest is not necessarily bad and not necessarily not deductible.

    You are capitalising interest because you are borrowing to pay it.
     
  5. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Yes - Capitalising interest. A likely tax scheme. Part IVA applies. Commissioner could determine the benefit is too hard to define and deny all deduction for interest.

    A tax benefit need not increase a deduction. It may maintain it which acts to increase the deduction v's if the scheme didnt operate. Its not the same as choosing IO. Thats arms length. An artificial attempt to maintain deductions while diverting cashflow elsewhere - scheme. eg pay off your PPOR home loan sooner.
     
  6. qikiqtarjuaq

    qikiqtarjuaq Member

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    Yes, my aim was not to reduce/increase interest, but to be able to divert new income into an offset/investments rather than using it to make repayments (without doing anything to the loan, such as switching to IO). But I think I get what Terry is saying about borrowing to pay interest, so it doesn't sound like an option.
     
  7. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    See the tax ruling from about 2012 on capitalising interest. It will depend on the reasons for doing so as to whether Part IVA might apply.
     
  8. Jess Peletier

    Jess Peletier Mortgage Broker & Finance Strategy, Aus Wide! Business Member

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    You might be better off using cashflow to pay the loan, but using the redraw to purchase investments. Split the loan first though.
     
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  9. qikiqtarjuaq

    qikiqtarjuaq Member

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    Thanks all - yes, was also considering other methods such as splitting to invest (and/or going IO), but also wanted to check other potential options.
     
  10. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    A very good point. While capitalising interest poses a problem for deductibility use of the equity for a new income producing investment may enable the enhanced interest to be claimed. The new investment can be property, shares, ETFs, LIC and so on...maybe even a new IP. The key issue is that the purchased investment produces income.

    So buying shares in Slater & Gordon would be non-deductible (as S&G have zip chance of paying a dividend), but Telstra pays a dividend and the expectation of income is clear. Just as loans can be blended I have alos seen unblended loans (ie all split correctly) and then the investor buys shares with no income producing purpose. So rather than a blended loan in that case you have mixed use investments and thats really hard to identify and in some cases hard to fix - eg if the original loan is not repaid and redrawn.

    The other way blending can affect the loan is when the original loan does not seem to correlate to the investments due to realised profits or losses. When profits occurs its important that the profit is NOT repaid to the loan...Only the capital for the original share purchase should repay. Many investor ignore this. It reduces deductions!! Also important is if a share loses value and is sold that the sale proceeds ONLY repay the loan. If this rule is followed the sum of losses to date + original loan will equal the current loan and this will maximise the loan.

    That said its a poor strategy that seeks to buy just any shares - Fundamentals must prevail. Perhaps a share with a decent income AND prospect for growth in value is desired. Just because a interest deduction can be claimed the fundamental issue of investment performance must still stack up.
     
  11. Anthony Brew

    Anthony Brew Well-Known Member

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    Hey, Terry did not say it is not an option. He said it is capitalising interest. You read in between the lines when there was nothing there to read. You are assuming this from the brevity of his post - and I think his posts are brief because he has explained it a thousand times before.
    Going by previous posts on this topic, you might still be able to use the money from redraw to pay the loan down, but you will need to get a private ruling (which was quoted at $1k).
    Basically the ATO wants to make sure you are not increasing your tax deductible loan so that you can use the same cash to reduce non-deductible loan. The ATO considers that a tax scheme.
    If you are not diverting the same funds to paying off non-deductible debt (ie PPOR) you might be able to get the private ruling in your favour. I would suggest getting some legal advice because if you can swing it, the benefit is significant, and I wonder if it would be fairly straightforward to get a private ruling if the funds you otherwise would have used go towards another investment instead of a PPOR which would mean it is not a tax scheme. I don't have any withdrawn funds right now, but when I do next, I will be seeking legal advice on this because I have no PPOR so there is no way it will be reducing my non-deductible debt since I have none. Do yourself a favour and go and looking into it further - unless your goal was to divert funds into a PPOR.
     
  12. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Private rulings are only as good as the honesty of the applicant as they come with a condition that all facts are disclosed. One single issue can taint the ruling... Its how most scheme promoters peddle their wares. They take 1+1 and make it equal 3. If you disclosed the intended purposes I suspect it would not be given and a general Part IVA warning view would apply as a scheme may be evident.

    Part IVA is less likely to apply if the redraw is used as an emergency cash buffer for a short term duration eg maternity leave and single family income in that period. Owners are short on cash and pay mortgage using the loan funds. Other examples are unemployment etc. I would think the unexpected nature of the need to use such a facility is important v's a longer term plan to do so.
     
  13. qikiqtarjuaq

    qikiqtarjuaq Member

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    To be fair, that's not quite true. I asked the question "Are there any adverse tax consequences?" to which he replied "Yes". That's not "nothing there to read", even if it's not conclusive. (And I did google quite extensively, so while I acknowledge he may have explained this particular issue a thousand times before, I couldn't find it.)

    But I have been considering whether a private ruling might be worth it, so I appreciate you sharing your thoughts and experience (and the price!). I am in the same boat, right now we have no non-deductible debt (except a credit card that gets paid off each month). However, because I want to divert the extra cash to offset with a view towards potentially buying a PPOR, that might muddle the issue. I agree the benefits would be significant, but that's why it might be ruled out. (The issues Paul raises do also bother me a little.) Best wishes regarding your own ruling, though!
     
  14. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    You seem to be talking about $20,000? at 5% pa the interest on this amount is $1000 per year. Any potential tax savings would be a max of $470 per year at the point when the full $20k is used up.

    Nothing to be sneezed at, but not a huge savings.
     
  15. qikiqtarjuaq

    qikiqtarjuaq Member

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    True, but in my particular case I was never trying to save interest - what I wanted to do is maintain P&I repayments but "divert" new cashflow, which means basically making the entire $20,000 available for future private use (eventually). There are obviously many ways to skin a cat, but I wanted to investigate this particular possibility before seriously considering splitting, refinancing to invest, etc (I just refinanced recently to uncross).
     

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